What is the real cost of capital for not-for-profit community health systems?

Historically, calculating cost of capital for asset-based financing for not-for-profit community health systems was relatively straightforward. The tax-exempt debt markets set the index rate and all other forms of capital were comparatively more or less expensive based upon simple and straight forward calculations of differential cost-to-borrow rates. A ten dollar calculator and one introductory finance course was all that was required. Furthermore, U.S. accounting standards favored long-term, tax-exempt debt over “more expensive” alternative capital access options such as third-party leasing.

Health care leaders, strategists and finance officers are challenged to broaden their perspectives on the consideration related to cost-of-capital evaluations.
Consideration such as:

1.    U.S. accounting standards are likely to move closer to the international standards. As a consequence, the comparative differences between the accounted costs of tax-exempt debt-financed facility assets and the accounted costs of leased-financed facility assets will change, making the lease option arguably more attractive than in the past (a).
2.    Speed to geographic targets becomes strategically useful, especially as it relates to staking-out key markets with larger, more sophisticated outpatient service sites. What is the real cost of losing a market, because tax-exempt debt capacity was constrained when the opportunity presented?
3.    What is “long-term” when considering the useful life of an expensive facility asset? Is every location a 25-30 year strategy? What value is there in preserving the right (by lease) to exit an unproductive market (and facility asset) by way of favorable lease termination rights?
4.    What is the value of preserving balance sheet liquidity for tactical opportunities such as mergers, acquisitions and physician integrations?
5.    How useful are historic standards of financial strength based upon scaled metric comparisons among peers e.g. “we are at the 70th percentile for days cash-on-hand within our peer group”. Absolute cash liquidity is most important; especially if many in the peer group are sinking.
6.    What is the real weighted average cost of capital (WACC) when bond covenants and bond rating agencies require significant levels of capital “lock-ups” to satisfy the risk requirements of tax-exempt debt sold to markets expecting stable, low-risk, tax-free returns.

Realistic evaluations of balance sheet positions and true costs of capital in the healthcare markets ahead are not simple math problems anymore. And, timely execution of strategic asset development and deployment will require health system leaders to step out of their hard asset financing comfort zones.  

(a)  Zismer, D.K., Fox J., Torgerson, P.; “financing strategic healthcare facilities – the growing attraction of alternative capital”; hfm, May 2013
Daniel Zismer, Ph.D.2013